Sep 5, 2022
Few are as well-positioned as Credolab’s Michele Tucci to analyse the overall state of play for the payments and fraud industry.
We spoke to Tucci on the evolving role of Credolab, the BNPL sector, and how an increased regulatory framework would impact the sector.
Michele Tucci: I am the Chief Strategy Officer for Credolab, as well as the Managing Director of our operations in North America and Latin America. Credolab was founded in 2016, and we are the largest developer of bank-grade credit risk scorecards based on smartphone metadata.
Credolab is committed to making credit available to all. We do this by giving businesses access to an untapped, highly-predictive source of behavioral data to help them make faster, better credit scoring, fraud, and marketing decisions with zero error rate. We pride ourselves on our data anonymity and security, as well as the principle of greater financial inclusion for more people worldwide.
MT: My initial reaction was that BNPL was a fancy way to market the same old POS loans but in a sexier way. When I looked deeper into it, I realized that there was a paradigm shift in the way fees were distributed, that these players were creating a win-win for merchants and consumers alike, and that checkout pages were getting a brand new payment option with a superior customer experience.
As an ex-Mastercard executive, I realized that some players in the ecosystem (credit card issuers) would have feared being disintermediated – just like it happened when PayPal started – and panicked to offer similar products or payment plans that resulted in cannibalising their own existing products.
MT: Increased regulatory oversight should be welcomed by the sector as a way to help it grow in a more sustainable way. I’m not arguing that BNPL players should be regulated like banks. This might simply result in a cramped ability to innovate, worse customer experiences, and perhaps even higher costs for borrowers. However, it doesn’t seem right that some players offer lending products without even having a lending license. Since a good percentage of BNPL consumers are youngsters that are trying credit for the first time, regulation should help prevent false advertising and hidden fees.
In the absence of regulatory frameworks, most BNPL players have prioritized growth and market share at the expense of onboarding high risk and fraud and relative costs. Yes, they were likely pushed by VCs looking for bigger and faster returns on their investment. However, that strategy worked when the cost of funds was low, venture capital abundant, and valuations generous. Now that the tide has changed, we have seen which BNPL players had been swimming naked.
A general framework might allow all players to compete and grow sustainably, while also protecting consumers.
MT: These are numerous! To list a few: neobanks are too slow in launching lending products; there is a high cost of acquisition of customers funded with VC money and high percentage of dormant customers (those that download the app and register, but never deposit funds in the bank account). There is momentum in gaining mainstream trust compared to main street banks, but this momentum is also very slow and hindered by limited offerings (limited to only an account plus a card in most cases).
There is also too much focus on niches. This could be a good thing if a particular neobank nails down the right approach and message and Unique Value Proposition for the segment they go after (for instance, black, brown, asian, LGBT communities), but we have yet to see any instances of that being done super well.
MT: There’s quite a bit, and we are reading into it closely every day. I saw in Bloomberg recently that funding in general for fintechs and specifically for neobanks is on a majorly downward trend, likely due to legacy banks’ investing in their own competing technologies. I think Klarna’s decline was also a major wake-up call in our industry. Credolab has gathered some very interesting data on neobanks that I will keep secret for now, as we hope to publish on this in the near future.
MT: There are many ways to answer the question, depending on the point of view. There is the issue of hidden debt resulting from BNPL players just starting to report the performance of their books to credit bureaus (this summer and just in the UK and US). Nobody knows for sure what is the outstanding balance held by BNPL players.
Another way to look at it is the hidden debt around some BNPL borrowers not realizing they are actually borrowing, and considering their installments as a delayed payment with their credit or debit card.
Either way, I see at least three problems for incumbent banks: 1) It might be possible that BNPL borrowers have a higher propensity to default, but banks wouldn’t know that because they don’t have the data. 2) Some banks are exposed to BNPL sector developments because they fund their deteriorating books (in terms of increased bad debt). 3) Some BNPL players also package up loans and BNPL credit and sell bonds as part of their funding mix. However, although the overall gross loss rates may be trending well as a percent of Gross Merchandise Value (GMV), given the short-term nature of transactions, net charge-offs should be reported as a percentage of the average loans outstanding in a given quarter, not as a percentage of the loan volume originated on the platform.
The issue with BNPL using GMV is that it understates bad debts by 25% on average. For example, a $100 purchase means that $25 is paid up front by the borrower – so it should not be measured as a risk. The real loan is $75 over 14-42 days, which is what can go bad.
The US shows what a massive risk BNPL is taking. It is way worse than any credit card (even at peak recession 2008-10). Note that the most recent USA chart for bad card debts is going down to 2.65% – yet BNPL bad debts are going up.
Having said all this, the actual size of the BNPL is still a fraction of the total unsecured credit lending pool. The UK has £1.6 trillion in mortgages, unsecured receivables of £250 billion in consumer lending, and £925.6 billion in debit and credit card spend (US$1.27 trillion). After seven years of BNPL lending in the UK, BNPL has a full 2.9 basis points of card spend or just 1% of unsecured lending.
MT: In Europe, there are startups taking interchange fees out of card payments with new, open banking regulation-enabled technology, which can read bank account details from a card and initiate a direct bank transfer. In the US, there is an “old” company that has been processing ACH payments called Dwolla. We could use the term “programmable fintech payments” as a way to refer to this type of innovation. In any case, these solutions are only just starting out in the market.
To be frank, I don’t think technical innovation can help here. Can we make payments at an unattended gas station or supermarkets more convenient than they are today?
With fuel and food prices at an all-time high, some consumers have gone back to cash or debit cards to ensure they only spend what they have. Some may have joined a Personal Finance Management (PFM) tool to keep a closer eye on, control, and track how much they’re spending. Some may have started using digital wallets in an effort to earn additional cashback or take advantage of merchant funded discounts or coupons focused on delivering tangible savings on everyday spending categories. And some consumers, unfortunately, may have simply increased their usage of revolving credit to pay even for discretionary purchases.
With BNPL already mainstream and with an increased number of credit cards offering installments at POS, I believe we should look at merchants (and payment providers/gateways) to do more to help customers by offering a broader range of payment methods that reflect consumers’ need for greater control, flexibility, and savings.
This article is originally from Payment Expert.
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